Options Are Available For Producing Income

After the stock market's 28-month slide, many weary investors now are much more interested in securities that generate regular income -- a financial return they can count on.

But investors face a special challenge today: Yields on money market accounts are near 40-year lows, and interest paid on high-quality bonds is paltry.

How do you figure out where to turn?

The average yield on a taxable money- market mutual fund is 1.33 percent, down from 1.59 percent at the beginning of the year, according to rate-tracking firm IMoneyNet Inc. in Westborough, Mass.

The yield on 10-year Treasury notes is about 4.75 percent, down from 5.11 percent six months ago.

Meanwhile, investors who earlier this year took a chance on certain higher-yielding alternative investments, such as corporate junk bonds, have been burned.

Junk bonds have sold off sharply in recent week as investors decided the economy's recovery won't lift many of these "fallen angels" soon.

And emerging-market bond mutual funds, the top-performing bond fund sector until a few weeks ago, recently demonstrated their classic volatility when they plummeted on fears that Brazil will elect a leftist regime that will default on the nation's debt.

As all of this spurs income-seekers to search far and wide for other ideas, options such as municipal bonds, the "stable-value" funds found in many 401(k) plans, and inflation-indexed Treasury bonds look attractive for conservative investors, experts say.

The more risk-tolerant may want to consider high-dividend-paying stocks or mutual funds that invest in these stocks (such as real estate investment trust funds).

However, a cardinal rule of investing should remain uppermost in income-seekers' minds, said Alan Papier, a senior analyst with Chicago fund-tracker Morningstar Inc.: "High yield is achieved only by taking on extra risk."

The risk these days is not just of more bond defaults by shaky corporate issuers, although that's clearly a concern. There also is so-called market risk: After 11 Federal Reserve interest rate cuts last year, the next direction for rates is almost certainly up, assuming the economy continues to recover.

And when rates begin to rise, the effect will be to depress the principal value of older securities that are locked in at a lower rate -- especially longer-term bonds, including otherwise super-safe Treasuries.

For income-seekers, that risk means investments have to be chosen very carefully. You have to decide whether you can stand any risk of loss to your principal, even on paper.

While today's bank CD rates won't make anyone rich, they can keep investors ahead of inflation while they wait for better alternatives. And it does pay to shop around.

Local newspapers, including the Sun-Sentinel in its Monday Your Business section, often publish lists of the high-paying bank and thrift CDs, but the most current rates are online: Bankrate.com, for example, lists top-paying institutions not only nationally, but by states and cities.

Bank and thrift CDs are as safe as Treasury securities -- up to the $100,000 per account limit on federal insurance. As with bonds, the longer you agree to lock up your principal, the higher the interest paid.

Recently, the highest rate on a one-year CD shown at Bankrate was 3.3 percent from ING Direct in Wilmington, Del.

Inflation-protected Treasury bonds

The current 4.75 percent yield on conventional 10-year T-notes is at least a positive return after inflation, but that could change fast if the cost of living surges. Why can't bond returns rise along with inflation?

The answer is that some do: Uncle Sam has issued bonds that guarantee a total return -- interest payments plus return of principal -- of about 3 percentage points more than the change in the consumer price index over time. If inflation shot up to 6 percent annually, the return on these Treasury Inflation-Protected Securities, or TIPS as they are known, would rise to 9 percent.

Pimco Funds and Vanguard Group both offer large mutual funds that invest in inflation-protected bonds.

Stable-value funds

These funds, an option in many 401(k) plans, also are available through mutual funds in some individual retirement account and college-savings plans. They usually hold so-called guaranteed investment contracts from insurance companies.

GICs essentially are fixed-income investments that sacrifice a small portion of return to purchase insurance against loss of principal.

Last year, 401(k) plan participants had 29 percent of their retirement assets allocated to stable value funds, up from 25 percent in 2000, according to a survey of plan assets. The average return for the year ending May 31 was 5.95 percent, according to Hueler Analytics, a Minneapolis data tracker. The average yield offered on stable-value funds was 5.79 percent as of March 31, the latest available data, Hueler said.